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WHY GERMANY
NEEDS STRUC-
Figure 1
REAL TOTAL DOMESTIC DEMAND IN GERMANY AND EU15
1991 = 100
140
TURAL REFORM
Germany
EU 15 - Germany
130
ECKHARD WURZEL*
120
O
bservers of the German
110
economy are facing an
apparently contradictory pic100
ture. On the one hand, economic
growth persistently undercuts
90
1991 1992 1993
that of the European Union by a
significant margin, on average
Source: OECD.
by some 1/2 percentage point relative to the other EU 15 countries over more than a decade. Domestic economic
activity is notoriously weak (Figure 1), which is
reflected in sluggish private consumption and investment, and progress in cutting high levels of unemployment appears to be lacking.
Weak domestic
economic activity
but strong export
performance
On the other hand, since the middle of the 1990s
there has been a secular increase in the economy’s
external competitiveness, as reflected by measures
of Germany’s real effective exchange rate vis-à-vis
its main trading partners. While the appreciation
of the euro within the last couple of years interrupted this trend with respect to export destinations outside the euro area, German competitiveness within the euro area continued to rise owing
to the country’s relatively low inflation rate
(Figure 2).1 German industry is very successful in
opening new export markets, in central and eastern Europe as well as in Asia, and since the beginning of the decade Germany’s share in world exports has increased significantly.
ty underline the need for structural reform, or are
we – on the contrary – dealing with a highly competitive economy with no need for an institutional
overhaul? Indeed, the success on external markets
indicates that Germany’s export sector is able to
address the challenges posed by a rapidly changing
international environment.2 In the same vein, the
German economy is a main innovator, and research
and development intensive industries contribute a
larger share to exports than in OECD countries on
average.3 Nevertheless, the observed gains in competitiveness on the one hand and weak overall
growth and employment due to weak domestic
activity on the other hand are to a considerable
degree two sides of one and the same coin. They
reflect adjustment processes in the overall economy
in response to adverse economic shocks, in particular those that occurred at the beginning of the
2 The dichotomy between strong export performance and weak
GDP growth plays a pivotal role in Hans-Werner Sinn’s recent analysis of structural shortcomings in the German economy. According
to Sinn a pathological boost of value added in Germany’s export
sector coexists with a strong increase in the import content of German exports, which is crucially related to high labour costs. See
Sinn, H.-W. (2003), Ist Deutschland noch zu retten?, Econ, Berlin;
and Sinn, H.-W. (2005), Die Basar-Ökonomie – Deutschland:
Exportweltmeister oder Schlusslicht?, Econ, Berlin.
3 According to key input indicators Germany belongs to the countries in the OECD with strong innovative activity, although
Germany’s relative stance appears to have weakened somewhat in
the 1990s. Also, the growth in multifactor productivity, which is
related to technical progress, decelerated in the 1990s. See the special chapter on innovation in: OECD (2004), Economic Survey of
Germany, Paris.
How do these two apparently diverse observations
fit together? Does the weakness of domestic activi* Eckhard Wurzel is Senior Economist and Head of Desk for
Germany and Austria at the Economics Department of the
Organisation for Economic Co-operation and Development
(OECD).
1 Other indicators also point to a trend increase in Germany’s international competitiveness. See Nerb, G. (2005), Wie schätzen deutsche Industriefirmen ihre Wettbewerbsposition ein?, ifo Schnelldienst 13/2005.
CESifo Forum 4/2005
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
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Focus
Figure 2
GERMANY'S INTERNATIONAL COMPETITIVENESS
a)
Real effective exchange rate, CPI based
have added to pressures to
adjust to a rapidly changing environment.
1993 = 100
80
Relative to 41 industrial countries
85
Unemployment
Relative to the other 11 members of the euro
90
Mounting unemployment, excess
capacities and – in the first half of
the 1990s – falling international
100
competitiveness with associated
105
losses in export market shares
triggered market adjustments
110
1990
1992
1994
1996
1998
2000
2002
2004
that have continued for more
a) Calculated using weights which take into account the structure of trade. A rise of the graph indicates an
than a decade. Wage increases
improvement of the competitive position. Data refer to western Germany 1989 and 1990 and Germany from
1991 onwards.
have moderated significantly
Source: OECD.
since the middle of the 1990s.
While real wages per hour – net
1990s, subject to an institutional framework that is
of employers’ social security contributions and deflatnot yet sufficiently well geared to support rapid
ed by the private consumption deflator – increased on
adjustment in favour of higher trend growth and
average by 21/2 percent annually between 1992 and
employment.
1995, since 1996 they have risen on average by 3/4 percent annually. Cost cutting programmes by business
entailed further reductions in employment while hirUnification
ing remained subdued. Indeed, measured in terms of
the number of hours worked, as opposed to headAt the beginning of the 1990s, the introduction of the
count, employment has trended down since the beginGerman Mark in the former GDR at conversion
ning of the last decade, with the volume of employrates far above the purchasing power of the old
ment in 2004 undercutting the level that prevailed in
GDR currency, social transfers to the eastern states
the 1993 recession by almost 6 percent. Over-capacity
associated with the extension of the west German
in the construction sector – largely induced by subsocial security system to the east, massive industrial
sidisation of projects in the eastern states – triggered
subsidies, and buoyant wage increases all combined
a trend decline in construction investment that is still
to produce a temporary boost in domestic absorpcontinuing. Equipment investment is driven to a contion that pushed up prices for domestically produced
siderable extent by the objective to streamline progoods relative to foreign goods. Rapidly rising govduction processes rather than to widen capacity, as
ernment debt added to this effect while high interest
surveys among enterprises confirm. Similarly, there is
rates put upward pressure on the nominal exchange
empirical evidence that offshoring of production is
rate. High wage settlements were sustained until
motivated to a significant degree by the need to cut
1995, with early retirement programmes, job creation
costs.5
schemes and related measures effectively insulating
collective wage setting from massive losses in
employment in the eastern states.4 Rising social
Regulation
charges contributed to the upswing in unit labour
costs. Overall, these factors triggered a real appreciEconomic adjustment along these lines helps to
ation of the DM that accompanied the swing in
restore and preserve competitiveness. However, outGermany’s current account from a sizable surplus
put and employment foregone can be considerable if
into deficit. Other events that occurred over the
raising competitiveness relies largely on prolonged
1990s and in the present decade, such as the transiperiods of retrenchment. By contrast, structural
tion to the European Economic and Monetary
change can become the vehicle that generates highUnion or the rapid economic development in China,
er income and employment if the regulatory envi95
4
Unification policies
resulted in high costs
in terms of debt,
unemployment and
subdued growth
5 For a recent survey among enterprises see: Deutscher Industrieund Handelskammertag (2005), Going International, Berlin.
By the middle of the 1990s employment in the eastern German
manufacturing sector had almost halved in comparison to 1990.
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CESifo Forum 4/2005
Focus
ronment fosters the reallocation of resources and the
expansion of activity in new areas. Wanted is a regulatory environment in which the economy can quickly transform gains in competitiveness into higher
overall activity, for example by utilising resources
that are saved via off-shoring for the development of
new lines of production at home. Germany’s subdued growth performance is characterised by lacking
job creation while productivity growth is not high
enough to compensate for the deficiencies in labour
utilisation.6 There is considerable scope to improve
the regulatory environment in various areas so as to
raise the capacity of the economy to generate
employment and raise productivity growth.
Needed are regulatory
and federalist
reforms to permit
flexible adjustment
marked reductions in the labour force and potentially adverse consequences for labour productivity
growth for the years and decades to come. At the
same time, the fiscal pressure on the social security
system and government finances more generally,
including those of the states and municipalities, is set
to increase.
Initatives taken
Notwithstanding sizeable challenges, past economic
adjustment toward viable market structures in the
new eastern states and restructuring in the overall
German economy provide a platform from which
higher growth and employment can be achieved. In
eastern Germany, new infrastructure has been established on a large scale and tremendous environmental damage inherited from the GDR has been remedied. Moreover, several reform initiatives that
became effective over the last couple of years are
significant steps in the right direction. This is true,
inter alia, for policies aiming at more efficient job
placement of the long-term unemployed, improving
the sustainability of the pension system, increasing
the efficiency of the health care system, and raising
competition in the crafts sector. However, in several
fields, including those where reform steps have been
taken, more needs to be done to raise Germany’s
economic potential.
The need for regulatory reform will not diminish in
the future. Raising the growth potential of eastern
Germany remains a major challenge. While fast
growth in various industrial branches of the economy cannot be ignored, a broader self-sustained
upswing of economic activity has not yet been
achieved, and a large part of total absorption in eastern Germany is still being financed via transfers.
Total factor productivity (TFP) in manufacturing has
been estimated to stand at around 70 percent of the
west German level.7 Since, on the other hand, production technologies in industry were found to come
close to those in the west, the gap in TFP is likely to
reflect structural weaknesses of the east German
economy that are unlikely to be remedied by subsidising capital accumulation, but require regulatory
reform.8
Federalism
Ageing
Policy formation – fiscal and non-fiscal – is often
subject to complex and opaque interactions between
the federal government and the states and communities. Increasing the consistency of policy initiatives
and the speed with which they can be designed and
implemented requires reform of the system of federal relations. Responsibilities for related tasks are
often split between the federal government and the
states and communities. Moreover, the high degree
of co-financing of spending across government levels
allows regional governments in principle to condition their approval of federal fiscal legislation in the
second chamber of Parliament (Bundesrat) on concessions in federal legislation that does not formally
require their approval, as experienced in the past.
There is an urgent need to untangle the responsibilities of the different levels of government and reduce
the degree of co-financing. One example of a task of
high importance for the future success of the
More generally, Germany’s economic and social system will be profoundly affected by demographic ageing. Germany belongs to the OECD countries with
the most significant deterioration in the age distribution of its population. According to the current
population projections of the Federal Statistical
Office, the old-age dependency ratio, defined as the
ratio of persons aged 65 and older to those aged
between 20 and 64, will rise to 53 percent in 2040,
from somewhat below 30 percent at present. Ceteris
paribus this development will be associated with
6
See OECD (2003), Economic Survey of Germany, Paris.
See: Beer, S. and J. Ragnitz (2002), “Wachstum des Ostdeutschen
verarbeitenden Gewerbes vor allem durch höhere Wettbewerbsfähigkeit der Unternehmen”, Wirtschaft im Wandel No. 13/2002.
8 See Wurzel, E. (2001), The Economic Integration of Germany’s
New Länder, OECD Economics Department Working Paper
No. 307,
http://www.oecd.org/dataoecd/60/57/1899874.pdf
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CESifo Forum 4/2005
30
Focus
crafts sector have been recently reduced but warrant
further deregulation. Regulation of professional
business services, such as those of architects and
engineers, is very restrictive by international comparison. Incidentally, Germany’s share in internationally traded business services is relatively low, and
competitiveness indicators point to much weaker
sectoral performance than in industry.9 It might not
come as a surprise that branches that are sheltered at
home tend to under-perform on external markets.
Fostering competition in network industries, such as
in telecommunication, energy supply and in postal
services, should also rank high on the policy agenda,
notwithstanding the significant progress that has
already been made in recent years. Streamlining
administrative regulation in a number of fields is
called for, and would help to increase labour productivity as firms can shift resources to productive
uses. This would promote firm entry, as administrative costs are particularly burdensome for small
enterprises.10 Further significant reductions in tax
concessions and subsidies also belong to a range of
measures that need to be addressed to improve the
allocative efficiency of the economy.
German economy, that will require streamlining the
federal decision structure, is raising the efficiency of
the education system.
Labour market
There are still significant hurdles to higher labour
supply, and a perception that economic growth is not
strong enough to prevent higher labour supply from
translating into higher unemployment, in particular
among older people. By contrast, in OECD countries
where participation rates of older workers are high
so are their employment rates, indicating that there
are few inherent barriers to higher employment of
older people. Germany’s tax wedge on labour is
among the highest in the OECD, requiring reform in
the social security system to reduce it. Reducing tax
and non-tax disincentives for spouses to take up
work, lowering benefit withdrawal rates for the longterm unemployed, and removing financial incentives
for early withdrawal from the labour force would
improve labour supply conditions. More efficient
activation of the unemployed requires further
reform of the Public Employment Service, including
revisions in the allocation of responsibilities across
different public administrations. The potentially high
costs of adjusting the regular work force to labour
demand conditions, implicit in Germany’s relatively
strict employment protection regulation for regular
employment, favours non-standard forms of employment. Fostering employment flexibility while developing incentives to invest in training would suggest
more symmetric reform of employment protection
legislation. Similarly, further progress is necessary in
allowing firm-specific and regional conditions to
impact on negotiated wage rates.
Germany’s tax wedge
on labour is among
the highest in the
OECD
Budget consolidation
Lasting budgetary consolidation is unavoidable if fiscal pressure stemming from society’s ageing is to be
coped with and the wherewithal for higher outlays is
to be created in areas that are vital for the development of the productive potential of the economy.
Over the last 15 years, general government debt relative to GDP increased by some 28 percentage
points. While unification played a major role in this
development, both in terms of spending increases
and debt take-over, the marked increase in indebtedness points to the need to respond to new fiscal
pressures by more stringent prioritisation of government spending. By 2004, almost 57 percent of general government outlays consisted of social spending,
up from 48 percent at the end of the 1980s, whereas
investment accounts for only 3 percent of spending.
A more rigorous approach to evaluating public sector spending projects against alternatives is called
for in various areas, such as health care, education,
active labour market measures, and infrastructure
investment. Redefining federal fiscal relations and
Competition
Product market competition is a driver for innovation and investment. Rents accruing to incumbents
due to a lack of competition reduce resources elsewhere, notably for the development or marketing of
new products. Also, prices that are higher than under
more competitive conditions – for example for energy or household services – diminish the purchasing
power of private households, weighing on consumption. While the German economy is traditionally
very open with respect to international trade, there
exist significant impediments to competition on
some domestic markets. Barriers to entry in the
9
See Nerb, quoted above.
For an evaluation based on enterpise surveys see: Institut für
Mittelstandsforschung Bonn (2004), Bürokratiekosten kleiner und
mittlerer Unternehmen, Deutscher Universitäts-Verlag, Wiesbaden.
10
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CESifo Forum 4/2005
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reducing industrial subsidies stand as examples of
policy requirements that could generate significant
savings in public budgets while improving the functioning of the economy.
Conclusion
Important challenges facing Germany, such as high
unemployment, adverse demographic developments
and the impact of globalisation, are common issues
within a wider set of OECD countries, notwithstanding the fact that reunification played a special role in
shaping Germany’s recent economic history. Indeed,
several other industrialised countries went through
periods of intense structural and fiscal reform that
were triggered by sub-par economic performance.
The new German government will need to firmly
anchor and broaden the path of the regulatory
reforms that Germany has recently embarked on.
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